Will US Shale Oil Undermine Its Own Success?

The US shale revolution has remarkably influenced global energy markets over the past five years. Can falling oil prices tarnish the extraordinary success of hydraulic fracturing in the US and turn it into a victim of its own success?

The continuous fall in oil prices over the past five months has created a significant stir in global oil markets. Key reasons for this sudden fall lie in a combination of factors: weak demand in Europe and Asia, higher than expected levels of production in politically unstable areas such as Libya and Iraq, increased US production and OPEC’s decision not to cut production. The downward oil price trend might continue in 2015. Analysts predict that prices could fall to $70 and $80 for the WTI and Brent benchmarks respectively in the second quarter of 2015.

It is still unclear why the OPEC, and its leading member Saudi Arabia, decided to keep relatively high levels of production, considering the fact that the oil glut might additionally slash oil prices. One potential scenario allows the possibility that the Saudis are counting on the negative effect which low prices might have on the US shale producers.

The shift still has not started to severely affect US shale producers, but the downward trend could change this outlook in the next 12-24 months. Since July, the price of Brent crude went down by 29%, from $115 to $85. Given that the average production cost of a barrel of unconventionally extracted oil varies between $50 and $80, the potential for the sustained low oil price levels must have a chilling effect on the US shale producers.

A more practical explanation is the fight for market share. With the increase in domestic production, US oil imports are shrinking rapidly, and US producers are exporting increasing quantities of oil products to Asia and Europe. According to the US Energy Information Agency, the US exported 401,000 barrels per day in July, which makes it the highest quantity in 57 years.

The Saudis and OPEC are aware that the cut in production would inevitably mean a loss of market share, but unlike the 1980s when the cartel had an absolute monopoly on the global oil production, the ascent of the US as the world’s largest oil producer has brought a new perspective to oil markets.

With the production of more than 8 million barrels per day, the US is getting closer to self-sufficiency in terms of oil consumption, and the administration is now closer than ever to considering the relaxation of the 40-year long ban on oil exports. It is estimated that by 2025, the country will export more energy than it imports.

In addition, US producers could prove to be more resilient to the oil price shocks than previously estimated. According to industry experts, most shale oil fields will still be economically viable at $60-$75 per barrel levels. The current price of the US crude benchmark West Texas Intermediate is around $82, which means that oil prices would have to go down by an additional $10-$20 in order to seriously disturb today’s level of production.

An oil glut and shifts in the supply and demand chain are the obvious reasons for falling oil prices. However, the circumstances surrounding the fall indicate that the oil markets are experiencing significant changes caused primarily by the US shale revolution. US crude oil production increased to 8.5 million barrels per day in 2014, which inevitably must have an effect on the global markets.

Regardless of any potential damages that the falling prices might have on its oil industry, the US economy will still experience the largest benefits from falling oil prices. This however cannot be said for OPEC members and Russia, where state budgets depend heavily on oil exports. Due to their vast financial reserves, Saudi Arabia and rich Gulf states can sustain low prices for longer periods of time. However, other producers such as Nigeria, Venezuela and Russia, with their frail finances and geopolitical strains, can hardly afford themselves an oil price war.